Risk off as melancholy mood engulfs financial markets

Daily Currency Update

The Australian dollar tracked lower through trade on Wednesday as a melancholy mood engulfed markets amid concerns that sustained inflation and sluggish growth will derail the global economic recovery. Equities and risk assets moved lower and the AUD gave up intraday highs at US$0.7235, slipping below US$0.72 to mark session lows at US$0.7175. US 10-year treasury rates punched back above 3% and ensured that the gains won in the aftermath of the RBA policy update were all unwound. Having eyed a break above near term resistance at US$0.7250 the AUD has struggled to maintain upward momentum despite markets pricing a more aggressive path to monetary policy normalisation. The clear signal proffered by the RBA has us pricing in 2 additional 50-point rate hikes and another 25-basis point hike before the year's end. With the RBA seeking to quell short-term inflation pressure, the pace of adjustment should slow next year. The shift in RBA policy expectations has helped lift AUD rates and erode some of the US dollar's yield advantage, opening the door for an AUD extension in Q4. With little of note on the local macroeconomic ticket, our attentions turn to Chinese trade data, a critical ECB policy update and US CPI data. Expectations the ECB will announce an end to QE and a plan to lift rates out of negative territory have matured in recent weeks as ECB officials signal an end to emergency policy settings. The ECB policy change and guidance will prove key in shaping AUD/EUR expectations and broader EUR/USD moves, which could afford the AUD some scope to test a break above US$0.7230/50.